At the time of the passage of the Dodd-Frank Act in 2010, many government officials, consumer advocates and even some housing industry participants concluded that at least one factor which contributed to the financial meltdown was securitizations of mortgages in which the securitizer retained none of the credit risk of the underlying assets. Generally, the securitization system as it had evolved was believed to over-emphasize the volume of securities issued versus the quality of the underlying assets.
This factor was addressed in Section 941 of the Dodd-Frank Act by adding Section 15G to the Securities Act of 1934 to require a securitizer of asset-backed securities to retain not less than 5 percent of the credit risk of the assets collateralizing the securities. Section 15G included an exemption, however, for asset-backed securities that are collateralized solely by residential mortgages that qualify as “qualified residential mortgages.” The statute left the meaning of “qualified residential mortgage” to be defined by regulation. Pursuant to that authority, federal regulators in April, 2011 issued a proposed rule requiring that “qualified residential mortgages” could have no higher than 80 percent loan-to-value ratio and no more than a 36 percent debt-to-income ratio.
Regulators drew significant criticism from mortgage industry advocates, however, because the proposed definition of a “qualified residential mortgage” did not match the definition assigned to the term “qualified mortgage” under the Consumer Finance Protection Bureau (“CFPB”) Ability to Repay rule. These advocates argued that failure to exempt “qualified mortgages” would restrict credit into the housing market and thus hurt consumers and the economy.
In response to this criticism, the proposed rule implementing the risk retention requirement of the Dodd-Frank Act has been recently revised by several federal bank regulatory agencies1 to give the term “qualified residential mortgages” substantially the same meaning as “qualified mortgages” as defined by the CFPB. Consequently, the new proposed rule eliminated the loan-to-value ratio requirement and increased the debt-to-income ratio to 43 percent. According to the regulators, the revised proposed rule meets the requirements of Section 15G of the Securities Act because the definition of “qualified mortgages” already eliminates certain toxic features of loans which contributed to the financial crisis (such as negative amortization and balloon payments), and the default rate on “qualified mortgages” are significantly below that of non-qualified mortgages. Critics of the revised proposed rule, on the other hand, will likely argue that the absence of a down-payment requirement (i.e., the elimination of any loan-to-value threshold) will encourage banks to make the same mistakes which in part caused the housing industry to collapse just a few years ago.
Adding further to the mix, the federal regulators also requested comment on an alternative approach, called “QM-plus." Under this alternative, the definition of “qualified residential mortgage” would be substantially similar to the “qualified mortgage” definition adopted by the CFPB, but would add certain additional features, including a maximum loan-to-value ratio of 70 percent. Opponents of this alternative definition will likely argue that if implemented it would restrict the flow of credit to consumers even more than had been proposed initially.
No one can predict with any confidence how this “Skin in the Game” rule will be finalized, although it seems unlikely that regulators would select a maximum 70 percent loan-to-value alternative requirement after eliminating it entirely in the revised proposed rule.
Comments on the proposed rule, as well as the alterative definition of “qualified residential mortgage”, are due to the CFPB by October 30, 2013.
1Office of the Comptroller of the Currency, Federal Reserve Board, and Federal Deposit Insurance Corporation, along with the Securities and Exchange Commission, Federal Housing Finance Agency, and Department of Housing and Urban Development